Estate Planning and IRAs: Selecting a Traditional IRA Beneficiary
Stretching out opportunities to maximize beneficiaries’ continued tax deferral of the IRA.
December 13 , 2007
by Deborah Ziolkowski, MST/CRTP
As individual retirement accounts (IRAs) become increasingly popular retirement-planning tools, it is important to understand their place in your IRA client’s estate plans. One of the most rudimentary questions to ask is who your client will name as beneficiary or beneficiaries? This question is often not given sufficient attention.
When determining the proper beneficiary for your clients’ IRAs, you must consider the same issues you would consider that affect your clients’ planning for estate taxes, multiple marriages or special needs children. Additionally, consideration must be given to the issues unique to IRAs, such as the required minimum distribution (RMD) rules. Some emphasis will be placed on the long-term opportunities to maximize the beneficiaries’ continued tax deferral of the IRA.
Required Minimum Distributions
As CPAs well know, an IRA is a retirement plan created under the provisions of IRC Section 408. Earnings within a traditional IRA are not subject to income taxes until they are distributed. The RMD rules govern the minimum amount of distributions required annually from an IRA, both before and after the client’s death.
The IRA client, or the beneficiary after the client’s death, always has the ability to take distributions larger than the RMD from the IRA, or to take a full distribution of the entire account. However, because of the tax-deferral benefits of IRAs, many clients and/or beneficiaries prefer to receive the smallest possible distributions from the IRA.
Application of the RMD rules may be affected by the client’s beneficiary selection. In 2001, the IRS issued proposed regulations that greatly simplified and improved the RMD rules. In April 2002, the final regulations provided and allowed for smaller required distributions.
Clients must begin receiving distributions from their IRA no later than the required beginning date (RBD). The RBD is April 1 of the year following the year in which the owner attains the age of 70½. Although clients have until the RBD to receive the first RMD, they must receive RMDs for all successive years by December 31 of each year. Clients most commonly use the Uniform Lifetime Table to calculate their RMD.
After the death of the client, RMDs will be based on the identity and qualification of the beneficiary as a “designated beneficiary” and whether the client dies before or after the RBD. The Single Life Table will be used to calculate the RMDs of designated beneficiaries.
Determination of the identity of the beneficiary and the determination of its status as a designated beneficiary are not required to be finalized until September 30 of the year following the year of the client’s death also called the “designation date.” The period of time before the designation date may provide a valuable opportunity to allow for postmortem planning by the beneficiary and the professional.
Separate Account Treatment
Regardless of whether the client dies before or after the RBD, the RMDs will be calculated using the life expectancy of the oldest beneficiary if there are multiple designated beneficiaries. However, there is an opportunity for some beneficial postmortem planning by using the separate account rules. If separate accounts are created for each of the designated beneficiaries prior to December 31 of the year following the year of the client’s death, each designated beneficiary may calculate RMDs using his or her own life expectancy.
The regulations provide the separate account rule is only available if the investment gains and losses accruing after the date of death are allocated pro rata among the beneficiary shares. The separate account rules are not available to the beneficiaries if the shares are determined under a pecuniary formula or for beneficiaries of a trust.
Naming an Individual As Beneficiary
The simplest form of beneficiary designation is naming an individual as the beneficiary of the client’s IRA. Many professionals consider this as the preferred form of beneficiary designation, absent any special estate-planning considerations. Having an individual as a beneficiary qualifies them as a designated beneficiary. They then have the opportunity to benefit from continued tax-deferred growth of the IRA by receiving distributions over a life expectancy. The reason it may be the preferred form of beneficiary designation is that there is probably less chance for the client or professional to inadvertently cost the beneficiary the tax-deferral opportunity.
Finally, there are many combinations of various estate-planning and tax-planning factors which are far too numerous to discuss here.
The IRA beneficiary designation should be part of your client’s comprehensive estate plan, unique to each and every individual. The plan should consider the client’s estate planning goals with the rules and regulations governing IRAs and strive for an appropriate balance.
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Deborah Ziolkowski has her Master of Science degree in Taxation from Golden Gate University. Ziolokowski has a tax and accounting practice in Sausalito, California. She has been a tax professional for 12 years.